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Words from the (Investment) Wise for the Week That Was (March 31 - April 6, 2008)

"This is one 'mother' of a market," 83-year old market veteran Richard Russell (Dow Theory Letters) aptly described what market participants were again faced with during the past week.

Although a sense of calm characterized financial markets, sentiment was fragile as the outlook was dominated by the familiar cast of deteriorating economic data, housing woes and concerns about the financial sector.

The Bear Stearns (BSC) bail-out transaction once again got the week going with JPMorgan Chase (JPM) agreeing to raise its buy-out bid for the embattled firm from $2 per share to $10 per share, and to stand in for the first billion dollars of losses (with the Fed taking responsibility for a further $29 billion).

Talking of banks, remember the story of the bank customer who asked the bank manager what the difference was between a recession and a depression? "In a recession, you lose your job. In a depression, I lose mine," came the reply from the manager (not to be confused with ousted Bear chief Jimmy Cayne).

And while we are on the lighter side of things, spare a minute to read (or sing along) the lyrics of these two "Bear songs": "Shine on You Crazy Dimon" and "The Night They Drove Old Bear Down".

Back to business. Central banks, especially the US Fed, were again active in providing additional funds to financial institutions. The Fed lent $75 billion of Treasuries for a wide range of mortgage assets held by banks. Loans to banks from the Fed's discount window rose, while average daily borrowing for the Fed's primary dealer facility was a large $32.9 billion.

"What we are watching today is a fierce and unrelenting battle by the Fed and Europe's central banks to avoid a collapse of the global banking system. To say the battle is deadly serious is an understatement," remarked Russell.

Following last week's announcement of the Office of Federal Housing Enterprise Oversight (Ofheo) relaxing its capital surplus restrictions on Fannie Mae (FNM) and Freddie Mac (FRE), a further positive development saw the Federal Housing Finance Board authorizing Federal Home Loan Banks to increase their purchases of agency mortgage-backed securities.

Before highlighting some thought-provoking news items and quotes from market commentators, firstly a briefly review of the financial markets' movements on the basis of economic statistics and a performance round-up.

The global picture is succinctly summarized by the conclusion of Moody's Economy.com for its latest survey of business confidence for the world: "Global business confidence remains very weak, slipping again last week. Assessments of present conditions plunged to a new record low, probably reflecting the Bear Stearns collapse and the resulting financial turmoil. The sentiment of those working in the financial services industry fell sharply to a new low.

"Confidence declined across the globe last week, consistent with recession in the US, near recession in Europe and Canada, below potential growth in South America, and growth just at potential in Asia."

US economic reports released last week showed further weakness in the US housing and consumer sectors, but a somewhat improved inflation reading.

The Conference Board's Consumer Confidence Index dropped to 64.5 in March, the lowest reading for the current business cycle, excluding the 61.4 mark seen in March 2003 when the war in Iraq commenced. Overall, the outlook for consumers is the gloomiest since October 1993.

Added concerns about the consumer arose with the Personal Income and Spending report for February, which showed only a 0.1% gain in spending and a flat reading on an inflation-adjusted basis.

The core PCE price index provided some good news from an inflation standpoint as it held steady at a year-to-year rate of 2.0%, albeit at the upper limit of the Fed's comfort zone of 1.0% to 2.0%.

The S&P/Case-Shiller Home Price Index, which measures prices in 20 US metropolitan areas, revealed prices declined by 10.7% in January - the largest drop on record (i.e. since 2001).

Commenting on a 2.9% increase in existing home sales for February, John Mauldin (Thoughts from the Frontline) explained: "Many of the home sales from February are foreclosures. Those are going to rise. The key pieces of data to look at will be the months of supply of homes for sale and foreclosures. Until the supply of homes gets back to 6 months, we will probably not have seen the bottom. Until we have worked through the millions of foreclosures that are in front of us, it is hard to think in terms of a bottom.

"We are in a [US] recession, and that means rising unemployment and falling consumer spending. It means tighter profit margins, etc. It is going to take a long time for the economy to recover. Welcome to Muddle Through," said Mauldin.

Elsewhere in the world, UK consumer confidence fell to a 15-year low in March and home prices fell for the fifth straight month. On a more upbeat note, Germany's Ifo survey of business confidence surprised on the upside, rising for the third consecutive month.


Date Time (ET) Statistic For Actual Briefing Forecast Market Expects Prior
Mar 24 10:00 AM Existing Home Sales Feb 5.03M 4.85M 4.86M 4.89M
Mar 25 10:00 AM Consumer Confidence Mar 64.5 74.5 73.4 75.0
Mar 26 8:30 AM Durable Orders Feb -1.7% 1.5% 0.8% -4.7%
Mar 26 10:00 AM New Home Sales Feb 590K 570K 580K 601K
Mar 26 10:30 AM Crude Inventories 03/22 88K NA NA 133K
Mar 27 8:30 AM Chain Deflator-Final Q4 - NA 2.7% NA
Mar 27 8:30 AM GDP-Final Q4 0.6% 0.6% 0.6% 0.6%
Mar 27 8:30 AM Initial Claims 03/22 - NA NA NA
Mar 27 8:30 AM Chain Deflator-Final Q4 2.4% 2.7% 2.7% 2.7%
Mar 27 8:30 AM Initial Claims 03/22 366K 360K 371K 375K
Mar 28 8:30 AM Personal Income Feb 0.5% 0.3% 0.3% 0.3%
Mar 28 8:30 AM Personal Spending Feb 0.1% 0.2% 0.1% 0.4%
Mar 28 8:30 AM Core PCE Inflation Feb 0.1% 0.0% 0.1% 0.2%
Mar 28 10:00 AM Mich Sentiment-Rev. Mar 69.5 70.5 70.0 70.5
Source: Yahoo Finance, March 28, 2008.

In addition to Fed Chairman Ben Bernanke's testimony on the economic outlook in Washington on Wednesday, April 2, the next week's economic highlights, courtesy of Northern Trust, include the following:

1. ISM Manufacturing Survey (April 1): The consensus for the manufacturing ISM composite index is 48.0 versus 48.3 in February. If the consensus forecast is accurate, it would be the third monthly reading below 50.2 in the last four months. Consensus: 48.0 versus 43.3 in February.

2. Employment Situation (April 4): Payroll employment in March is expected to post the third monthly decline (-50,000) following a loss of 63,000 jobs in February. The jobless rate is predicted to have risen to 5.0% from 4.8% in February. Consensus: Payrolls: -50,000 versus -63,000 in February; unemployment rate: 5.0% versus 4.8% in February.

3. Other reports: Construction spending, auto sales (April 1), factory orders (April 2), ISM non-manufacturing (April 3).

The performance chart obtained from the Wall Street Journal Online shows how different global markets fared during the past week.

Source: Wall Street Journal Online, March 29, 2008.

Global stock markets closed the week higher, with the MSCI World Index rising by 2.4%.

Emerging markets rebounded from the sell-off of the previous two weeks and surged by 6.4%. Leading the charge were the Hong Kong Hang Seng Index and the Indian BSE 30 Sensex Index with increases of 10.3% and 9.2% respectively. The Shanghai Stock Exchange Composite Index was the exception with a loss of 5.7% over the week, but made up excellent ground with a gain of 4.9% on Friday.

The major US indices lagged international markets, with the Dow Jones Industrial Index falling by 1.2% and the S&P 500 Index losing 1.1% during the week. However, the Nasdaq Composite Index (+0.1%) and the Russell 2000 Index (+0.3%) managed to eke out small gains.

Banks and broker/dealers were the worst-performing areas in the US, shedding 8.4% and 7.1% respectively for the week as sharp earnings estimate cuts expedited profit-taking after the strong gains of the previous week. Retailers (-4.1%) also took a big hit, with a warning by JC Penney (JCP) souring the outlook.

On the positive side in the US, oil services (+6.9%), materials (+6.1%) and gold and silver stocks (+4.8%) provided some joy.

Click here for a scorecard for a number of global stock markets, indicating the index movements since each of the respective markets' highs in US dollar, euro and local currency terms.

Fixed-interest instruments
The past week saw the yield on the 91-day Treasury Bill creeping up from 0.54% to 1.32%, showing more confidence as investors moved out of T-bills into higher-yielding securities.

On the mortgage rate front, the 30-year and 15-year US fixed rates were 13 basis points (5.85%) and 21 basis points (5.40%) higher respectively.

Government bonds kicked up over the week as safe-haven buying receded. The yield on the 10-year US Treasury Note increased by 13 basis points to 3.47% (aided by the Treasury selling $136 billion in new stock), the 10-year German Bund rose by 19 basis points to 3.94% and the 10-year UK Gilt edged up 13 basis points to 4.42%.

Click here for my recent post "US long bonds in injury time".

The US dollar resumed its downward trend last week as the weakening economic data created the expectation of a further 50 basis point interest rate cut at the FOMC's meeting next month. The euro, however, rallied as Mr Jean-Claude Trichet, chief of the European Central Bank, rejected calls for an interest rate cut after a surprise rise in German business confidence this month, insisting that fighting inflation was his priority.

The US dollar lost 2.1% against the euro over the week and also weakened against the Swiss Franc (-1.1%), the British pound (-0.4%), the Australian dollar (-1.7%) and the New Zealand dollar (-0.8%). On the other hand, the Japanese yen gave up 0.5% against the US dollar as risk aversion took a back seat, putting the low-yielding currency under pressure.

Iceland became the first deficit state succumbing to investor flight, forcing the central bank to raise interest rates to 15% this week in an emergency move to halt the collapse of the krona. The Icelandic currency lost a further 2.7% against the euro, having fallen 18% since mid-March.

A combination of US dollar weakness and supply concerns triggered a rebound in commodities from the previous week's losses, resulting in the Dow Jones-AIG Commodity Index gaining 3.9% for the week.

Recoveries were staged across the spectrum of commodities: crude oil (+3.7%) gold (+1.8%), platinum (+8.8%), silver (+6.5%), copper (+7.2%), nickel (+6.6%), corn (+8.6%) and soya beans (+4.4%).

West Texas Intermediate oil jumped to $108.22 a barrel on Thursday after an attack on Thursday on the Basra export terminal in Iraq, but retreated to $105.62 a barrel by the close of the week.

Precious metals were unable to regain their record highs and David Fuller, author of Fullermoney, cautioned: "... despite the recent bounces, it would be premature to assume that we have seen the reaction lows, for what on past evidence is a multi-month shakeout within the long-term bull markets for precious metals".

Monday's release of the Prospective Plantings report from the US Department of Agriculture is eagerly awaited as soft commodities have been the major recipients of commodity investments over the past few months.

Rice prices jumped by 30% to an all-time high on Thursday, raising fears of fresh outbreaks of social unrest across Asia where the grain is a staple food for more than 2.5 billion people. Global rice stocks are at their lowest since 1976.

"I maintain that most agricultural commodities are currently in medium-term corrections and will be joined in this process by those that are still accelerating, such as rough rice. Consequently, investors should expect a period of underperformance by agricultural commodities and shares, which have run ahead of their current potential," said Fuller.

Now for a few news items and some words and graphs from the investment wise that will hopefully assist to make sense of the markets' actions during the week ahead.

Source: Lisa Benson, Slate, March 26, 2008.

Bloomberg: Grant calls Fed's balance sheet an "Economist Nightmare"
"James Grant, editor of Grant's Interest Rate Observer, talks with Bloomberg's Pimm Fox in New York about the Federal Reserve's intervention in the credit market crisis and its impact on the value of the US dollar."

Source: Bloomberg, March 25, 2008.

GaveKal: Start increasing risk in portfolios
"In recent weeks, we have often highlighted how commodity markets and bond markets were dislocating, and how this dislocation had created forced selling on the equity markets. However, over the last few days, there have been some positive signs that markets are perhaps starting to return to a slightly more normal state.

Bond markets. Yesterday, yields on the US ten-year benchmark bond jumped by +22 bp to 3.56%, the biggest one-day increase since April 2004. This sell-off on government bonds came after US existing home sales rose +2.9% in February (expected -0.4%), the first positive reading in seven months, sparking hopes that the US housing meltdown is now slowly stabilizing. On the corporate side, credit-default swaps on the Markit CDX North America investment grade index dropped by -18.5 bp to 140.7 bp, the lowest level in a month This CDX index has now dropped more than -51 bp since the Fed's March 16th decision to back JPMorgan's purchase of Bear Stearns and allow investment banks to borrow directly from the Fed through a new lending facility. While corporate bond spreads are still at a very high level, this new trend of narrowing spreads, if sustained, is a very positive sign for the financial markets in general.

Commodities. Commodity markets have been dominated by investors and financial speculators, rather than real physical demand and supply. This has caused commodity markets to price the underlying goods at levels which far exceed any fundamental justification. However, over the past two weeks, we have seen commodity prices come down markedly: Wheat prices have lost -20%, copper is down -5.1%, nickel has lost -10.3%, and - most importantly - crude oil has shed -8.2%. So what does this mean? Our perma-bear friends will be quick to point out that this is simply a result of markets adapting to a recessionary scenario. But as we see it, the ongoing correction on commodities probably has a lot more to do with the internal market structure than any external factors. What we are seeing now is most likely a result of financial speculators being taken out and commodity markets slowly returning to a more normal state of affairs.

"We have made the case that global stock markets have been held hostage by the major dislocations occurring in the bond markets and in the commodity markets. If these markets are now starting to normalize, then maybe stock markets will be able to find some relief. As such, it might make sense to start increasing risk in the portfolios."


Source: GaveKal - Checking the Boxes, March 25, 2008.

Goldman Sachs: Stagflation to return?
"Stagflation, low economic growth combined with high inflation, gets mentioned more and more in the press. Global growth is slowing down (we forecast to 3.6% from 4.7% in 2007) and inflation appears to be picking up, particularly in emerging markets. Although we forecast global inflation to rise from 3.4% in 2007 to 4.5% this year, we see it falling back to 3% thereafter.

"Stagflation, as the world experienced in the 1970's, is difficult for policymakers and companies to deal with. Rising inflation affects the ability of central banks to pursue accommodative monetary policy when growth is weakening. Rising inflation can place downward pressure on margins, particularly if inflation, like what happened in 1970's, is driven by wage inflation.

"Our conclusion, by looking at the German, UK & US equity markets is that an environment of stagflation is the worst for equities with mostly negative returns. An environment where inflation stays low turns out to still offer positive returns even if growth is also low.

"We believe that the fear for stagflation is overdone, as the focus that the central banks, particularly the ECB and Bank of England, have on inflation will ensure higher inflation will not become entrenched. We also see no evidence that wages are rising significantly on the back of rising commodity prices, as we saw in the 70's. We are however closely monitoring the developments with regards to inflation, as we do believe, as mentioned above, that initially the growth/inflation picture will become worse before inflation moderating again."

Click here for the full report.

Source: Goldman Sachs, March 25, 2008.

Ambrose Evans-Pritchard (Telegraph): Fed's rescue halted a derivatives Chernobyl
"We may never know for sure whether the Federal Reserve's rescue of Bear Stearns averted a seizure of the $516 trillion derivatives system, the ultimate Chernobyl for global finance.

"'If the Fed had not stepped in, we would have had pandemonium,' said James Melcher, president of the New York hedge fund Balestra Capital. 'There was the risk of a total meltdown at the beginning of last week. I don't think most people have any idea how bad this chain could have been, and I am still not sure the Fed can maintain the solvency of the US banking system.'

"All through early March the frontline players had watched in horror as Bear Stearns came under assault and then shrivelled into nothing as its $17bn reserve cushion vanished.

"Melcher was already prepared - true to form for a man who made a fabulous return last year betting on the collapse of US mortgage securities. He is now turning his sights on Eastern Europe, the next shoe to drop.

"Fed chairman Ben Bernanke has moved with breathtaking speed to contain the crisis. Last Sunday night, he resorted to the 'nuclear option', invoking a Depression-era clause to be used in 'unusual and exigent circumstances'."

Source: Ambrose Evans-Pritchard, Telegraph, March 24, 2008.

Telegraph: Worst may be yet to come, warns ECB's Trichet
"European Central Bank chief Jean-Claude Trichet warned that global markets were in the midst of a major correction which recalled the 1997 to 98 Asian financial crisis and the first global oil shock.

"'I wouldn't say the worst is behind us,' the ECB president told European Union lawmakers in Brussels. 'If we don't learn the lessons of the past we will find ourselves faced with the same problems that we encountered during the first oil crisis.'

"He said countries then had responded to higher prices by raising wages and salaries which had fuelled an inflation spiral, choking off growth and causing widespread, stubborn unemployment that dogged Europe for decades.

"'Never forget, mass unemployment in Europe started with the very bad reaction after the first oil shock in 1973. We had no mass unemployment in Europe before the first oil shock. We were at full employment in practically all the economies in Europe.'

"However, Mr Trichet rejected calls for an interest-rate cut after a surprise rise in German business confidence this month, insisting that fighting inflation is his priority."

Source: Telegraph, March 27, 2008.

Financial Times: US can learn from Japan's crisis
"The US should inject public funds into its financial system, which is undergoing a worse crisis than that experienced by Japan during its non-performing loan crisis, according to Japan's financial services minister.

"'It is essential [for the US] to understand that given Japan's lesson, public fund injection [into the financial sector] is unavoidable,' Yoshimi Watanabe told the Financial Times.

"Although 'it is very difficult for Japan to convey such a message to a foreign government ... Japan could, for example, convey - through the G7 [meeting of finance ministers] or central bank governors' meeting - Japan's lesson and that we are prepared to take co-ordinated action if necessary' to help resolve the situation, Mr Watanabe said.

"US and European central banks are to consider the possibility of using public funds to purchase mortgage-backed securities as a potential remedy for the crisis.

"The remarks are the first public expression of concern by a Japanese cabinet minister that the impact of the current financial market turmoil could be much more serious than Japan's experience during its 'lost decade' of abnormally slow economic growth in the 1990s."

Source: Michiyo Nakamoto, Financial Times, March 23, 2008.

Financial Times: Central banks expected to buy mortgage-related assets
"Central banks and governments in advanced economies will be forced to buy mortgage-backed securities within the next few months to stop the credit crisis, according to a former chief economist of the European Bank for Reconstruction and Development.

"'Central banks will be managers for years to come of rather interesting portfolios,' predicted Professor Willem Buiter of the London School of Economics, as the Federal Reserve and the Bank of England sought to play down conversations officials have had regarding purchases of mortgage-related assets.

"The Financial Times reported on Saturday that conversations had taken place concerning such plans, as part of a broader, early-stage exchange as to possible future steps in battling financial turmoil. The fact that such a move is being discussed at all indicates the depth of concern that exists over the health of the banking system.

"Both the Fed and the Bank of England rejected any suggestion they were proposing to buy mortgage-backed securities or were discussing firm plans to do so.

"A senior Fed official said: 'The Federal Reserve is not involved in discussions with foreign central banks for co-ordinated buying of MBS.'

"A Bank of England spokesman said: 'Central banks, including the Bank of England, have been looking at ways to ease the strain. The BoE is not, however, among those reported to be proposing schemes that would require the taxpayer, rather than the banks, to assume the credit risk.'"

Source: Chris Giles, Financial Times, March 23, 2008.

Ian Gordon (The Long Wave Analyst): Total US debt at lofty levels

Source: The Long Wave Analyst, March, 2008.

Times Online: White House and Fed divided on taxpayers bailing out banks
"A rift is emerging between the White House and the US Federal Reserve over whether banks should be bailed out by taxpayers, The Times has learnt.

"It is understood that President Bush and his advisers are concerned about the repercussions of protecting a financial institution from bankruptcy because of its own poor decisions. The White House is anxious about the long-term implications of a bank bailout and of the extension of emergency cheap credit facilities to investment firms.

"In what is an election year in the United States, the President is worried that Washington will be accused of using taxpayers' money to protect executives, staff and shareholders from the consequences of poor risk management. He also fears that Wall Street will become mired in new, onerous regulation."

Source: Suzy Jagger, Times Online, March 27, 2008.

John Mauldin (Thoughts from the Frontline): Liars don't deserve taxpayer money
"If we do end up with a government bailout, and I agree that it's likely, I sincerely hope that no one who cannot document that the information they submitted for their no-documentation loan was accurate will be given any assistance. If you lied, you do not deserve taxpayer money. If you took out a loan on which you could not demonstrate that you could make the payments, just because you wanted to profit from a resale of a home which was 'surely' going to rise, you should not get tax-payer money. For every person we help like that, we keep a house from going down to a price that someone who deserves a home and has played by the rules could buy. Just my take."

Source: John Mauldin, Thoughts from the Frontline, March 28, 2008.

Asha Bangalore (Northern Trust): 2007 - Q4 GDP unchanged; weaker economic conditions expected in Q1
"Real gross domestic product grew at an annual rate of 0.6% in the fourth quarter of 2007, which is unchanged from the preliminary estimate. Estimates of inflation, both overall and core, were revised down slightly.

"Incoming data for the first quarter support our forecast of drop in GDP in the first quarter. Equipment and software spending should be weak based on January and February data of shipments of non-defense capital goods excluding aircraft. Retail sales numbers and auto sales for January and February suggest that consumer spending could possibly post the first drop in consumer spending since fourth quarter of 1991. Construction expenditures and housing market information indicate a drop in residential investment expenditures."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 27, 2008.

BCA Research: US Leading Economic Indicator - more tough times ahead
"The Conference Board's Leading Economic Indicator (LEI) warns of further weakness in the next six months.

"The latest decline in the LEI is a fresh reminder that the US economic slowdown is not over and risks are to the downside. The LEI has been below its boom/bust line since mid-2007 (based on a deviation from trend). It does a good job leading trends in real GDP growth ... The persistent weakness in the LEI implies that interest rate cuts aimed at curing financial sector distress are justified based on economic trends. Further easing (rate cuts and non-conventional tactics) looms as the authorities try to prevent the credit crisis from infecting the rest of the economy."

Source: BCA Research, March 26, 2008.

Asha Bangalore (Northern Trust): The Chicago Fed's Index reinforces expectations of a recession
"The Chicago Fed's National Activity Index (CFNAI) dropped to -1.04 in February from 0.68 in January, the weakest reading on record for the current business cycle. The 3-month moving average of the CFNAI was -0.87 in February, the third consecutive monthly reading exceeding the demarcation line of -0.7. According to the Chicago Fed, when the '3-month moving average of the CFNAI moves below -0.7 following a period of economic expansion, there is an increasing likelihood a recession has begun.' Need we say more?"

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 24, 2008.

Asha Banglore (Northern Trust): Consumer spending shows sharp deceleration
"Nominal consumer spending grew 0.1% in February following a 0.4% gain in the prior month. However, inflation adjusted consumer spending held steady in February ... The year-to-year change in inflation adjusted consumer spending is 1.66%, the smallest increase in five years. A further deceleration in consumer spending is likely in the months ahead given the weak employment conditions, slowing growth in compensation and sharp reduction in mortgage equity withdrawal, which had given strong support to consumer spending in the 2004 to 2006 period."

Source: Asha Bangalore, Northern Trust - Daily Global Commentary, March 28, 2008.

Paul Kasriel (Northern Trust): It's so over for household spending
"Households have been running deficits - i.e. spending more than their after-tax income - since just before the peak in the NASDAQ stock price index.

"There are only two ways to spend more than you earn - borrow and/or sell assets. Households have been doing both to fund their recent deficits. These two deficit-funding sources will dry up in the coming years, which will force households to, at least, attempt to begin running surpluses again. Regardless of whether they are successful in their attempt to run surpluses, growth in household spending on goods, services and tangible assets, such as houses, is bound to slow significantly in the coming years.

"The data in the chart begin with 1929. In the preponderance of years from 1929 through 2007, households ran surpluses. Prior to 1999, there were only six years in which households ran deficits - 1932, 1933, 1947, 1949, 1950 and 1955. During the Great Depression of the 1930s, households were borrowing or selling assets just to survive."

Source: Paul Kasriel, Safe Haven, March 25, 2008.

John Authers (Financial Times): US consumer and voter
"The source of the uncertainty is the US, and operates at two levels: how will US consumers spend, and how will they vote?

"As other measures showed the US sliding into a recession, consumer confidence refused to join in - until Tuesday. The Conference Board's index of consumer optimism dropped last month to 64.5, from 76.4. It has been lower than that just once this decade. That was in March 2003, the month of the Iraq invasion. Before that, consumers had not been this worried since the 'jobless recovery' of July 1992. This categorically signals a recession.

"This, like 1992, is a US presidential election year. Then, consumers' pessimism virtually gave the Democrats the presidency. Markets had assumed the same would be true in 2008 - until recently.

"The Iowa Electronic Markets' presidential futures have seen a sharp shift in the past few days. They now put the Republicans' chances, for a long time less than 40%, at 46.4%, their highest since February last year.

"Many in the market might like a Republican president but a resurgence of uncertainty is unwelcome. Political issues confront the market at present that go beyond economic or foreign policy. Should the US bail out the mortgage market? Will it clamp down on banks' regulation to ensure such a crisis never happens again?

"These questions are technical and subtle, but they are also unavoidably ideological. They will affect securities markets the world over. From markets' perspective, this is the worst time in decades for political uncertainty in the US to return. But that is what has happened."

Source: John Authers, Financial Times, March 25, 2008.

Standard & Poor's: Case-Shiller home price indices continue decline
"Data through January 2008, released today by Standard & Poor's for its S&P/Case-Shiller Home Price Indices, show declines in the prices of existing single family homes across the United States continued into the new year, with 16 of the 20 reporting MSAs posting record low annual declines, of which 10 are in double-digits.

"The chart above depicts the annual returns of the 10-City Composite and the 20-City Composite Indices. Both of the composite indices are now reporting annual declines in excess of 10%. The 10-City Composite set yet another new record, with an annual decline of 11.4%. The 20-City Composite recorded an annual decline of 10.7%.

"'Unfortunately it does not look like early 2008 is marking any turnaround in the housing market, after the declining year recorded throughout 2007,' says David Blitzer, Chairman of the Index Committee at Standard & Poor's. 'Home prices continue to fall, decelerate and reach record lows across the nation. No markets seem to be completely immune from the housing crisis, with 19 of the 20 metro areas reporting annual declines in January ...'"

Source: Standard & Poor's, March 25, 2008.

Paul L. Kasriel (Northern Trust): Case-Shiller Home Price Index - Bell curve of doom?

"According to the Case-Shiller Composite 20 (metro areas) index, the price of an existing home peaked in July 2006. From the July 2006 peak through January 2008, the price of a representative home has fallen 12.5%. To put this in perspective, if someone had purchased an existing home in July 2006 for $1 million with a downpayment of $125 000 (12.5% of the purchase price), that someone's equity in the house as of January 2008 would be approximately zero. The Case-Shiller home price index represents a bell curve of doom for recent home purchasers and home lenders."

Source: Paul L. Kasriel, Northern Trust - Daily Global Commentary, March 26, 2008.

The New York Times: Equity loans as next round in credit crisis
"Little by little, millions of Americans surrendered equity in their homes in recent years. Lulled by good times, they borrowed - sometimes heavily - against the roofs over their heads.

"Now the bill is coming due. As the housing market spirals downward, home equity loans, which turn home sweet home into cash sweet cash, are becoming the next flash point in the mortgage crisis. Americans owe a staggering $1.1 trillion on home equity loans - and banks are increasingly worried they may not get some of that money back.

"To get it, many lenders are taking the extraordinary step of preventing some people from selling their homes or refinancing their mortgages unless they pay off all or part of their home equity loans first. In the past, when home prices were not falling, lenders did not resort to these measures.

"Such tactics are impeding efforts by policy makers to help struggling homeowners get easier terms on their mortgages and stem the rising tide of foreclosures. But at a time when each day seems to bring more bad news for the financial industry, lenders defend the hard-nosed maneuvers as a way to keep their own losses from deepening.

"It is a remarkable turnabout for the many Americans who have come to regard a home as an ATM with three bedrooms and 1.5 baths. When times were good, they borrowed against their homes to pay for all sorts of things, from new cars to college educations to a home theater."

Source: Vikas Bajaj, New York Times, March 27, 2008.

Bill King (The King Report): Free reserves fall below requirements
"The Fed reports that its discount window loans to primary dealers jumped $8.2 billion to $37 billion. Fed holdings of US Treasuries declined $47.9 billion to $629 billion ... TAFs jumped $20 billion to $80 billion ... Free Reserves are a stunning MINUS $21.646 billion, which is the amount BELOW reserve requirements.

"MZM continues to grow, if not Weimar, at least 1980 Mexico. MZM's four-week moving average growth annualized is 36.8% for the latest reporting period according to the St. Louis Fed. MZM is +12.2% y/y.

Source: Bill King, The King Report, March 28, 2008.

Financial Times: South Korea pension fund shuns US debt
"The world's fifth-largest pension fund will no longer buy US Treasuries because yields are too low. The move signals what could be a big shift by financial institutions away from US government debt into higher-yielding assets.

"South Korea's National Pension Service, which has $220 billion in assets, said on Wednesday it wanted to broaden its range of overseas investments. 'It is difficult to buy more US Treasuries because the portion of our Treasury investment is already too big and Treasury yields have fallen a lot,' said Kwag Dae-hwan, head of global investments at the NPS. 'We need to diversify our portfolio away from US Treasuries and we find asset-backed securities and corporate debt more attractive because of wider credit spreads.'

"A manager at the NPS's overseas investment team said: 'The Fed continues to cut interest rates. We are still making profits from the Treasuries that we bought in the past but we think we'd better dispose of them and had better buy higher-yielding European-government debt.'

"Central banks from 16 Asian countries said last weekend at a meeting in Jakarta that they might invest more of their $1,000 billion of official reserves in one another's sovereign bonds instead of US Treasuries, given the dollar's volatility."

Source: Song Jung-a, Andrew Wood and Michael MacKenzie, Financial Times, March 26, 2008.

Richard Russell (Dow Theory Letters): US dollar will determine appetite for Treasuries
"Yesterday we heard that South Korea would no longer accept US Treasury bonds because the yields were so low. My immediate thought was, 'Good excuse, but the real reason was probably that South Korea no longer wanted US paper.'

"... the Achilles Heel of the US is the reserve status of our dollar. Should the dollar lose or even start to lose its reserve status, we'd be in huge trouble. Borrowing from our overseas friends would immediately become more difficult and interest rates would have to head higher."

Source: Richard Russell, Dow Theory Letters, March 28, 2008.

Bloomberg: Dollar's moves force whispers of "I" word
"For the first time in 13 years, people who trade currencies say confidence in the markets to determine exchange rates is dwindling. The crisis that may bring the so-called Group of Seven nations to coordinated intervention is the result of a sinking US economy, the weakest dollar since 1971 and the biggest currency fluctuations this decade.

"'The risks of coordinated intervention are going to increase in the second quarter for sure as the dollar weakens further,' said Mitul Kotecha, head of foreign-exchange research in London at Calyon.

"Even with the latest gain against the euro, strategists at Deutsche Bank in Frankfurt, the world's biggest currency trader, say the dollar is likely to fall to $1.60 versus Europe's common currency ... because of a recession. Royal Bank of Scotland, the fourth-largest trader, says the risk of intervention is increasing and 'would become severe' if the dollar depreciates below $1.60."

Source: Gavin Finch, Bloomberg, March 24, 2008.

The Globe and Mail: Emirs take pity for now, as dollar days near their end
"The United Arab Emirates will keep the dirham pegged to the US dollar. The Emirates' central bank was 'conceding to US pressure,' Bloomberg says, after US embassy officials paid a visit to the UAE central bank governor to register their concern about reports that he was considering dropping the peg.

"US officials clearly still recognize the value of owning the premier monetary brand in the world. What's less clear - what's doubtful in fact - is how long Americans, who borrow $700 billion (US) every year from foreigners, will enjoy the privilege of owning the world's reserve currency. If history is a guide, according to James Grant, the dollar's days in the sun are limited, and there are repercussions for investors."

Source: Fabrice Taylor, The Globe and Mail, March 22, 2008.

Financial Times: Chinese exporters shun flagging dollar
"Rising numbers of Chinese exporters are shunning the US dollar or devising ways to offset the impact of the falling currency as they confront rising labour and raw material costs at home.

"According to Alibaba.com, the online company that matches Chinese suppliers with international buyers, the vast majority of their almost 700,000 Chinese suppliers no longer use dollars to settle non-US transactions to minimise foreign exchange risk.

"'They are moving to euros, pounds, Australian dollars, or even quoting prices in renminbi,' David Wei, chief executive, told the Financial Times. Moreover, he added, prices quoted in dollars were now often valid for just seven days compared with the 30 to 60 days common previously.

"The dollar has long been the currency of choice for Chinese and other exporters around the world. However, the impact of its recent weakening has led exporters to begin questioning its place as the de facto world currency."

Source: Robin Kwong, Financial Times, March 27, 2008.

Paul Kasriel (Northern Trust): A profits recession
"With today's release of 'final' (until revised yet again) Q4:2007 GDP, the Commerce Department also issued its estimate of Q4 corporate profits. The profits data are not encouraging. The first chart contains year-over-year percent changes in annual averages of both total before-tax corporate profits from current production (the Commerce Department's equivalent of operating profits) and domestically-generated before-tax profits.

"The total profits data includes profits earned by US corporations earned from foreign operations. With the dollar having fallen in 2007, profits from foreign operations get 'inflated' when translated back into dollars. Total profit growth, including earnings from overseas operations, grew at 2.7% in 2007 versus 13.2% in 2006. The 2007 total profit growth was the slowest since 2001, when the economy was in an official recession.

"Profits from domestic operations contracted by 3.0% in 2007 - the first contraction, again, since 2001. As Merrill Lynch economist, David Rosenberg, has pointed out, US corporate hiring and US corporate capital spending depend on US generated profits, not profits generated overseas.

"There has been some talk that the recent weakness in corporate profits is due to the problems being encountered by the financial sector. Excluding the financial sector, everything is rosy. Well, it really does not matter. As the second chart shows, both financial sector as well as nonfinancial sector profits fell in 2007. Nonfinancial sector profits fell 3.7% in 2007, the first decline since 2001. Financial sector profits fell 1.8% in 2007, the first decline since 1998."

Source: Paul Kasriel, Northern Trust - Daily Global Commentary, March 27, 2008.

David Fuller (Fullermoney): Stock prices forming a base
"A massive deleveraging is underway in the overleveraged US economy. This started with the banks (yield curve recapitalisation, and is affecting all other borrowers, not least consumers who are now being forced to rebuild their personal balance sheets.

"Judging from other credit contractions, the US's deleveraging process will probably take several years. This is a healthy process although the journey will be painful for many, not least because of America's overdependence on the financial sector and consumer spending.

"The Federal Reserve, White House and Congress will use every effort to cushion downside risk during this process. Inevitably, this is somewhat controversial since rather than allow a widespread and devastating debtors' collapse, the government is trying to mitigate a deflationary contraction, erring on the side of future inflation and additional bubbles.

"I think the US government will succeed in this effort, because following a slow start last summer and early autumn, the Fed has caught up with the curve of events. Moreover, Fed Chairman Ben Bernanke is an acknowledged expert on the Great Depression of the 1930s, so a repeat of that outcome is the least likely possibility, on his watch.

"But how will Bernanke stem a vicious cycle of mortgage defaults and falling house prices, especially as short-term rate cuts have had little or no effect on mortgage rates? Not easily - I would not be surprised to see an overall price correction of approximately 40%, but the answer is nationalisation.

"Arguably, this is already underway and I expect the government, one way or another, to eventually own most of the dodgy mortgages. Yes, this will bail out the banks although not before considerable financial damage has occurred, as we have already seen. More importantly for the government, it will also assist debt-strapped voters.

"How will the stock market respond to the nationalisation of $trillions in mortgages? It will love it. Historically, house prices often lag and money will chase performance. Once fears of a widespread financial collapse triggered by house prices abate, investors will gravitate increasingly towards equities in preference to additional real estate, which is the most recently burst bubble.

"I maintain we are already seeing the basing process in price charts for most equity sectors. It is likely to be a long convalescence for some, not least because the US economy is likely to grow below its long-term trend for several years.

"My guess is that the leaders will be big, cash generative, multinational companies. For instance, Wal-Mart will continue to grow but many small retailers will suffer due to insufficient consumer demand.

"How will other stock markets around the world perform? The Wall Street leash-effect will remain important. It has exerted a largely negative pull since the July and October 2007 highs. However, if the Dow and S&P 500 continue to range above their January and March lows many of the stronger GDP growth economies should eventually attract additional investor interest.

"Meanwhile, long-term investors will need to remain patient more often than not, although each dip in prices now provides buying opportunities. Short to medium-term traders can harvest some of the ranging on a buy-low-sell-high basis."

Source: David Fuller, Fullermoney, March 27, 2008.

Richard Russell (Dow Theory Letters): Has the stock market discounted the worst?
"The news seems to get grimmer and grimmer. So why isn't this stock market falling apart or even crashing? The reason is that the stock market has probably already discounted the grim news. The market never discounts the same thing twice. At the January lows, I believe the D-J Averages discounted the WORST that could be seen ahead.

"I never doubt the extraordinary ability of the stock market to 'see' ahead, to discount the future. The real problem, is that very few people are capable of reading or deciphering what the market is 'saying'.

"The market could remain fluctuating in 'no man's land' for quite a while - at least until the housing foreclosure mess appears to have hit bottom. I think housing remains the chief worry for the Fed, for Washington and for the markets."

Source: Richard Russell, Dow Theory Letters, March 27, 2008.

Jeffrey Palma (UBS Investment Bank): Prospects for equity rally are good
"The prospects for a more sustainable rally in equities appear good, says Jeffrey Palma, strategist at UBS Investment Bank, who sees reasons for optimism in global stock markets, in spite of increased volatility, stability concerns and expectations of a US recession.

"'The policy reaction to financial market turmoil has become increasingly aggressive, particularly from the Federal Reserve,' Mr Palma says. He argues that this should help dissipate the uncertainty that has depressed equity market valuations.

"UBS is preparing for a shift to a more positive assessment of short-term prospects for markets, based on policymakers' response to the crisis and further steps that might be taken.

"'This does not imply that the days of worry and volatility are things of the past,' Mr Palma says. 'But past examples of banking system bail-outs should offer hope to investors.'

"Mr Palma says previous rebounds suggest those sectors that have been under the most pressure also recover best. UBS has increased its allocation to financials and consumer discretionary stocks. But it cautions that both sectors must repair their balance sheets and that this is a hurdle that is unlikely to be cleared quickly."

Source: Jeffrey Palma, UBS Investment Bank (via Financial Times), March 24, 2008.

John Hussman (Hussman Funds): Stock market not yet offering investment merit
"The possibility of a 'bear market rally' aside, if the S&P 500 has already set its low, it will have been the first time that the market has responded to a similar economic downturn with less than a 20% loss on a closing basis. If we define the recent downturn as a bear market anyway, the recent low will represent the highest level of valuation that has ever prevailed at the bottom of a bear market. I expect neither of these to be true for long ...

"High bearishness is typically not a positive early in bear markets, because the initial decline is often fairly deep. In short, aside from some potential for a 'clearing rally' to correct the short-term oversold condition of the market, even the low advisory bullishness figures provide little evidence for a 'contrary opinion' call on the market.

"We won't observe 'investment merit' until we observe significantly lower valuations, but market action by itself could encourage a somewhat more constructive stance. For now, the weight of the evidence continues to demand a strong defense."

Source: John Hussman, Hussman Funds, March 24, 2008.

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